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Level 137

Market Failure: Externalities, Public Goods


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market failure
a situation in which the market does not provide the ideal or optimal amount of a good
externality
a side effect of an action that affects the well-being of third parties
negative externality
the condition when a person's or group's actions impose a cost (an adverse side effect) on others
positive externality
the condition that exists when a person's or group's actions create a benefit (beneficial side effect) for others
marginal social costs (MSC)
the sum of marginal private costs (MPC) and marginal external costs (MEC): MSC = MPC + MEC
marginal social benefits (MSB)
the sum of marginal private benefits (MPB) and marginal external benefits (MEB): MSB = MPB + MEB
socially optimal amount (output)
an amount that takes into account and adjusts for all benefits (external and private) and all costs (internal and private); the amount at which MSB = MSC. sometimes referred to as the efficient amount
internalizing externalities
an externality is internalized if the persons or group that generated the externality incorporate into their own private or internal cost-benefit calculations the external benefits (in the case of a positive externality) or the exte…
Coase Theorem
Externalities are problematic because of TCs
rivalrous in consumption
a good whose consumption by one person reduces its consumption by others
public good
a good for which there is nonrival consumption
nonrivalrous in consumption
a good whose consumption does not reduce its consumption by others
excludable
a characteristic of a good whereby it is possible, or not prohibitively costly, to exclude someone from receiving its benefits after it has been produced
nonexcludable
a characteristic of a good whereby it is impossible, or prohibitively costly, to exclude someone from receiving its benefits after it has been produced
free rider
anyone who receives the benefits of a good without paying for it
Asymmetric Information
situation when one party doesn't know enough about the other party to make accurate decisions. This creates two kinds of problems:
Adverse Selection
This happens before the transaction
moral hazard
the risk that one party to a transaction will engage in behavior that is undesirable from the other party's point of view